Sooner or later in your real estate investing career, you’ll find yourself having to decide which of several promising markets to invest in. Each property provider (home builder, turnkey provider, real estate agent, etc.,) will tell you their market is the best and why you should invest there.
What you need is a way to do a real estate market analysis so you can decide where to place your bets. In this article, we’ll discuss six attributes of a good real estate market:
- The numbers work
- Good property management
- Diverse local economy
- Job growth
- Population growth
A Real Estate Market Analysis in Two Primary Steps
Step 1: Initial Screen
#1: The numbers work
My first screen when doing a real estate market analysis is: Do the numbers “work” in this market?
Some markets have a poor rent-to-value ratio i.e., the rents are low relative to purchase price, so you’ll have negative cash flow. That doesn’t work for me. I want a market where the properties pay for themselves while I’m building equity.
To illustrate, compare the metrics for San Francisco, CA vs. Port Charlotte, FL, near Ft Myers:
This is an extreme example, but it illustrates how the numbers don’t work for a city like San Francisco. The purchase price is so high relative to the rent that it has negative cash flow of almost $5,000 per month.
The old rule of thumb was the “one-percent rule” which states that, ideally, you’d want the monthly rent to equal 1.0% of the property’s purchase price e.g., $1,000/month for a $100,000 property. That 1.0% ratio is very hard to achieve in today’s market, but at current interest rates, a property would need a rent ratio of at least 0.6 or higher to break-even. The Port Charlotte property has a rent ratio of 0.67 ($2,300/$345,000).
(Also note that, for the same amount of money, you could buy four brand-new houses in Port Charlotte for the price of one, 100-year-old house in San Francisco!)
For me, the numbers on the San Francisco property just don’t work. Imagine losing your day job and having that much negative cash flow! That said, a lot of people have made a lot of money in California real estate by accepting the negative cash flow and banking on price appreciation.
If you’re less risk-averse than I am, just remember that you’re getting a sure thing (negative cash flow) in exchange for a not-so-sure thing (future appreciation).
Also, if you’re looking at properties that have only $200/month in negative cash flow, you may decide you can live with that. You have to decide what numbers work for you or not.
- Whoever is selling you the property should have a proforma financial statement itemizing rents and net cash flow after expenses;
- You can do a sanity check on those proformas by going to Zillow.com to check housing prices and rents in the same zip code you’re considering buying in. Confirm that the seller’s numbers are realistic.
#2: Good Property Management
The most common reason real estate investments fail is poor property management, so I always recommend investors identify at least two good property managers in any given market. That way, if the first one doesn’t work out for whatever reason, you’ve already identified a backup.
The property management company should be a real company, not a mom-and-pop operation out of someone’s house. There should be a “deep bench” of managers, leasing agents, handymen, etc., so service won’t be interrupted if someone’s on vacation or if there’s personnel turnover.
Note: Requiring two good property management companies may effectively eliminate smaller metros. It’s hard enough to find one good property management company but finding two such companies in a metro with a population of less than 100,000 can be difficult.
- Your property provider should have a recommended property management company, so you should evaluate them and see if they’ll work for you. To find a second (backup) property manager, you can:
- Go to Yelp.com and search for “residential property management” and “city name” and look at the ratings. Many will have negative ratings from disgruntled tenants, so focus on the ratings by landlords;
- Go to Meetup.com and search for real estate investor clubs where the property is. Email the Meetup Group organizer and ask for recommendations.
If you can’t find at least one and preferably two suitable property management companies, then you should stop there and pass on that market.
#3: Diverse Economy
Not having a diverse economy is a deal-breaker for me personally, so I’m including it in this initial real estate market analysis screen. If it isn’t a deal-breaker for you, you could save this attribute for the next section.
My reasoning is that single-industry metros like Detroit or Las Vegas tend to get hit harder during recessions. When times are bad, the first thing consumers cut back on is discretionary spending like a new car or a trip to Vegas.
Worrying about whether my tenants will lose their jobs with every downturn in the economy is one more wild card I don’t want to deal with. I want to limit the number of variables outside my control.
You can determine how diverse a local economy is by going onto Google and searching on “city name” plus “top 20 employers” and look at the number of jobs in each industry. For example, compare the results of Atlanta vs. Detroit:
Atlanta’s major employers are all in different industries: Delta Airlines, Home Depot, UPS, Coca-Cola, Emory University, Center for Disease Control, SunTrust Bank, Georgia Tech, AT&T, Marriott, and countless hospitals.
By contrast, although it’s trying to get more diverse, the bulk of jobs in Detroit are still in the auto industry: Ford, Fiat-Chrysler (Stellantis), General Motors, Magna International (auto supplier), Quicken Loans and health care.
With a diverse economy like Atlanta’s, if one sector of the economy is struggling (e.g., Delta Airlines during the Covid pandemic), then other sectors of the economy can pick up the slack. That makes for a more resilient market and more stable cash flow for investors.
Step 2: Deep Dive
Ok, at this point we’ve eliminated the markets that don’t meet our initial real estate market analysis screen without investing too much time on them. Now we can do a deeper dive on the “semi-finalists” that passed our initial screen.
#4: Job Growth
New jobs in an area are a bullish sign for that area’s growth because someone has determined that the business climate there is promising enough to make the investment.
For example, Intel is currently building a chip factory just northeast of Columbus OH that will create 3,000 jobs starting in 2025. Those are high-paying jobs and will pump lots of money into the local economy, including its real estate.
This is the kind of market you want to invest in.
- The seller of the property you’re investing in will have information if jobs are moving to the area as part of his “pitch” for why it’s a good place to invest.
- Check the city’s Chamber of Commerce website for press releases about new jobs
- Google “what companies are expanding in “+ “city name”.
Make sure you locate where on the map the new jobs are coming in. An Intel plant northeast of Columbus will likely have no effect on housing demand in southwest Columbus. Consider commuting distance and traffic patterns when determining where to invest.
#5: Population Growth
Though job growth usually results in population growth, the two are not always in sync, so they should be tracked separately.
For example, parts of Florida are popular destinations for retirees, so their population growth is greater than their job growth, since retirees don’t need jobs. In other places with high unemployment such as Detroit, a new Amazon warehouse might create new jobs but not increase the population, because there are enough unemployed people there to absorb any job creation.
A growing population is important because it means demand for housing will go up, which means rents and property values will likely go up.
- Again, whoever is offering to sell you the property should have information on this.
- Other information sources vary from city to city, so Google searches are your friend here.
- To save you time, here’s a list of the top 40 fastest growing metros in the US from 2023 – 2060. Note that The Villages, FL (the largest retirement community in the country) is #1.
Sometimes you can find city-specific information by searching on “city name” + “population growth forecasts”. Here’s the Orlando forecast:
Note that though the rate of growth is slowing (bottom graph), the metro is still expected to grow by 400,000 people in the next 15 years.
In addition to the quantity of population growth, you should also consider the quality of population growth. Many retirees in Florida bring lots of capital with them, so it’s not just the number of bodies that matters but also the amount of money they can pump into the local economy.
Retirees with money will sell their homes in New York and buy homes in Florida all-cash, and spend money in restaurants, golf courses and for entertainment. Follow the money.
#6: Investor Friendly
Our last desirable attribute for a market is that it be investor-friendly, namely one that makes it easy to do business there.
Some markets have high property taxes (Houston); others require a city inspection every time a property is sold (St. Louis); others have a time-consuming process to evict non-paying tenants (San Francisco).
While these may not necessarily be deal-breakers for you, you should be aware of the business climate before investing. This is why I’m including this tip for your real estate market analysis.
- Look up Real Estate Investor Associations (REIAs) or real estate investing Meetup.com groups, and find
investors who own properties in multiple cities. An investor in only one city knows only his market and what he thinks of as “normal” in his market might be very abnormal when compared to other markets you’re considering.
Your property manager
- Similarly, you shouldn’t ask your property manager “Is this city investor friendly?” because she may not have anything to compare it to. Instead, you should ask very specific questions.
- How long does it take to evict a non-paying tenant? What’s the process and how much does it cost?
- Does the city require periodic inspections? How long does that take to schedule and complete?
- How often are property taxes reassessed?
Then compare those answers to the answers from other markets you’re considering and decide what market you’re most comfortable with.
This back-of-the-envelope market analysis may seem like a lot of work at first, but after you’ve done it a few times, you’ll find you can do your initial screening in about 10-15 minutes. The deeper dive could take a little longer.
Performing this real estate market analysis will give you the confidence you need to stop “analysis paralysis” and start investing.
Few markets will “check all the boxes” and provide the perfect place to invest. If there was such a market, it’d be too hard to get property there because all the Wall Street private equity funds would be snapping them up.
You’ll have to decide for yourself what criteria are your “deal breakers” and use those in your initial screen.
The only non-negotiable in my opinion is property management: If you can’t find good property management, your investment is almost certain to fail. All the other criteria are up to you.
But knowing that the numbers work, knowing that there’s good property management, a diverse economy, job and population growth and an investor-friendly environment will help you pick the best markets for you.